November 28, 2005

Ramnath, in his second point here, repeats the usual argument that “Ownership doesnt matter as much as competition” refering to privatization of PSUs. The argument is that if PSUs were forced to compete in a free market, then it wouldn’t matter that they are publicly owned.

Sorry, but I don’t buy that argument. To compete in a free market, the company should want to succeed. A company is not a person, so when one says that a “company should want” something, he is treating a complicated web of desires as the wish of a single entity. The company official in charge of competing gets orders from his boss, who in turn gets targets set by his boss, and this chain goes on till the CEO, who in turn is given directions by the board, and the board gets its priorities from whoever appointed it.
In a private company, the board is appointed by the shareholders and to the extent that the price of shares depends on the performance of the company, the actions of the low-level official are conducive to the company’s competing in a free-market economy. Not perfectly, I must admit. The fact that this chain is complicated ensures that the incentives get misaligned, which is why bigger companies often get outwitted by nimbler small companies.

But in a public companies, the board is appointed by the bureaucrat who is appointed by the minister who is appointed by the Prime Minister who is responsible to the Lok Sabha whose members are elected by us. Now if you honestly think that we who are concerned about waste of public money can manipulate this intricate system of levers to influence the behaviour of that official, I have a bridge to sell you. It goes from Mumbai to Dubai right over the Arabian Sea.

Of course, that is not exactly what Ramnath is thinking. He is thinking that if the government has the “political will”, it can set for its PSUs the same priorities that a private company’s shareholders set for their board. But really, the government does not have a “political will” independent of its constituents. Do you ever think that a government will ever put profits above the interest of its employees? Government employees have a union can go on strike now, while profits made will benefit a lot of people who simply cannot match the organization of the unions. Whom do you think the government will lean towards?

The ultimate weapon that keeps a private company on tenterhooks is survival. There are private companies that are as mismanaged as public companies, but that doesn’t last long. They either shut down, get bought over, or gird up their loins when faced with impending doom. Ramnath holds out the fond hope that the Left parties may even join us if we call for transparency, reduction in red tape and corruption. I don’t know why. Does he really think that the Left will support us if we demand a cut in labour force, or, God forbid, a closure of the company because it is too inefficient to succeed? As to the argument that it will fight corruption, I’d like to introduce him to Mr. Sharad Rao, the head of Mumbai Municipal employees union, who recently called for a strike after octroi employees were arrested for corruption. In fact, he is the one responsible for continuation of octroi in Mumbai. His ostensible complaint is that if octroi is abolished, his union employees will lose their jobs, but he insists on this argument even after he was given ironclad assurances that not a single employee will be fired. The only possible conclusion, I’m afraid, is that his concern is not for their jobs, but for their bribes.

There are other reasons why PSUs remain inefficient even in a competitive market.

The first case is when the government digs up the level playing field to give PSUs an advantage. Example: BSNL. Private telecom operators actually pay BSNL for calls they, the private operators are carrying on their own network- in the form of the ADC.

The ADC is supposed to cross-subsidise BSNL’s loss-making rural connections, but all it does is make STD calls on other networks more expensive.

The second case is when private operators are able to bribe the government to give PSUs a disadvantage. No examples for this, but Arun Shourie claims that the Indian Airlines aircraft purchase was held up for so long precisely because Jet and Sahara were paying off civil aviation ministry officials to let the decision die.

In India, public policy has become hostage to PSU interests. Witness the sorry state of non-freedom in the aviation and telecom sectors where the Govt heavily tilts the scales in favor of reigning PSUs AI, IA and BSNL in the process raising the economic deadweight loss by reducing quality, raising prices and starving the PSUs all at the same time.

Still, competition is much better than entire industries being dominated by PSU monopolies. Competition will either force efficiency or result in loss making PSU’s. Once these companies go into the red and there net worth goes to the crapper, the left will finally permit their privatization.

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I will go out on a limb here and argue against the blind way people think that COMPLETE privatization is good in India. People nowadays point to cellular phone penetration vs. landline telephone penetration figures…

I agree upfront with what you say in your post, that, the way the government runs the Public Sector Unit’s (PSU) is bad. But what Ramnath in his post was trying to highlight the fact that first and foremost we owe something to those in unfortunate circumstances than us. I have posted some thoughts on Tim Worstall’s blog here (opens in new window, please scroll to the end)…

A mix of private and public is the answer.

Many people have posted on what is wrong in PSU type system in India and elsewhere (especially the former Soviet Union and its bloc, though I think the real reason the Soviet Union collapsed was not their sick PSU’s). Private systems focus on survival yes, and now quoting you here:

“Do you ever think that a government will ever put profits above the interest of its employees?

Most private companies in the United States now focus on short-term profits to the exclusion of long-term growth or vision. Witness the sinking of a once reputable company in Silicon Valley who are now primarily sustaining their business (majority of profit is obtained) on selling printers. It is not purely the company interest only or employee interest only; it should be a synergy of the two. Private companies are driven to this extreme by some of their shareholders who want them to show a profit every financial quarter. It is impossible to be profitable quarter after quarter after quarter. Suppose Company X holds 100% of the market for processors, (there is no competition from anyone) they sell to 1 billion people on Earth, and they reduce prices to sell to the other 5 billion. They wait for the upgrade market to pick up newer PC’s; they wait for processors to be installed in your cars/stereos/whatever. A time will come when there is slackening demand, not because of their fault but because they have exhausted all their potential avenues by selling to all their potential customers on Earth. Company X will then have to pray that there is life outside Earth so they can sell more processors to ET and his lovable friends.

Think, if this doesn’t apply to every (or maybe just unnecessary) product sold under our system of modern capitalism as practiced in the US, and maybe Europe, and maybe elsewhere. I don’t know about other places, people who have been there would know more.

What then happens to the employees of Company X?

The company got enormous profits, and it gave a relatively measly amount to the people who helped the company. Now that it is impossible to grow, it is time for the axe.

Many people talk about corruption in PSU’s, what about the paychecks of CEO’s running these private companies? Even when the growth is anemic or non-existent (as in massive loss), under the current system they should be accountable, but they are not. But I argue that if and given if: what they are trying to accomplish succeeds, they deserve their six/seven/eight whatever figure salaries and stock options. But the major rub is that they cut XXXX amount of jobs, and the amount goes for increased compensation into the hands of a select few, and NOT to the shareholders.

The situation is the same, from my deck chair, for both the majority of PSU’s and private companies.

Okay, returning back to the topic of private cellular phone companies in India and their high/wonderful penetration and their low low rates, which are the cheapest in the world. The next step will be mergers and acquisitions, because the low rates maybe unsustainable or they want more moolah (Remember the famous Pepsi Hindi slogan ‘Yeh dil mange more’). Now then, because competition is reduced they will jack up the rates, typical monopoly behavior. Economics 101. That is the strategy, which will be followed: low prices, and then price hikes. What we are witnessing in India is the first act; maybe the second act has started, I don’t know if they are doing merging/acquisitions because I don’t follow the market.

What Ratan Tata and maybe others are getting into is this particular aspect of the whole picture. As an aside, I have the greatest respect for ‘Sifu’ Lee Kuan Yew. And I think that the current system of capitalism would change to take this into account. Now the question whether the change is ever so slowly and gently transitioned or is abrupt nobody knows. But I would prefer to live in a place, which has a visionary leader, who understands the big picture.

Amit, you skillfully pointed out the weaknesses faced by private companies when they go PUBLIC. This does to some degree create an incentive to look for short term gain. But you should then compare this to the incentives of many PSU’s. There number one priority is not their products, margins, customer satisfaction, but only their employees.

I agree with you. Private companies who are publicly listed face this problem, but there are listed private companies which resist this pressure. But they are few and far between.

And I agree with those who say that those PSU’s who put their employee’s concern above their profitability are crazy. i.e PSU’s in India are bad for everyone but their employees (short term only, long term they become bad even for employees, the subsidy ends sometime, when somebody’s patience runs out).

What I am driving at, is the fact that you can’t swing from one extreme to the other.

Going private is not a panacea for all ills people!

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Abhinay,
I should have clarified this but I thought it was clear in the context I mentioned:

I don’t follow the Indian market closely as much I as follow the market in the US

Define free market. Is it perfectly competitive market? If thats what you refer to then in a perfectly competitive market no one earns profit. (i.e. economic profits are zero, those are different than accounting profits. Economic profits are based on opportunity costs and in a perfectly competitive markets MV=MC, profits = 0).

If its not a perfectly competitive market, then we are talking about monoploies or oligopolies where firms have some market power or ability to set prices. In such cases firms will try to maximise profits (I think thats what you mean by succeed.. but again define succeed- maximising profits, maximising revenues? what)

And now, where does ownership come into picture?

Your argument that government funds loss making PSUs etc, have nothing to do with owenrship as such. That’s catering to special interest groups. Managements incentives not aligned with profit maximisation shouldnt be a worry in a competitive market. The firm will go out of business irrespective of who owns it. A case can be made about an observed behavior, but the points you make are not relevant)

To achieve economic efficiency, whats important is – we should avoid regulatory behavior and let the market be (unless an efficient outcome is not achieved as a result of market equilibrium, e.g. network externalities, public goods etc., or patronised monopolies through patents – pharma industries)

But by and large a case can be made against regulations.

Whether government wants to compete in a certain industry or not is a very different problem. Its more to do with governmetns ability to compete and creat value or capture value in a particular market. Its a same problem as whether a glass making firm should enter hi-tech market or not. Whether Dell should write OS and compete with Microsoft or not, and whether Kodak should produce digital cameras. Most of the time the answer is no for different reasons – lack of core competence, misaligned incentives etc.

But as such, in a free market (where there are no artificial barriers to entry), who owns a firm is immaterial from an economics perspective. Its an important strategy decision for survival of the firm, but for the whole economy, it should not matter. Assumption: Its a competitive market.

The fact that common Indian mindsight has an aversion for private sector is due to the fact that private sector is thought promote private wealth and increase discrimination and disparity amoung the rich and the poor. The fact remains that with the free market economy though there is incentive for growth and wealth creation, due to the prevalent inequality that exists in the world today it has widened the divide between the rich and the poor creating more revulsion and aversion for free market economy. Hence, the role of government is critical in arming the proletariat with free education and health and providing them the much needed level playing field to compete with the rich and mighty.

ecentric,
I was under the impression that the aversion to private jobs was due to acountability associated with being employed for one. If you have a government job in India you are pretty much set for life regardless of how bad you are at your job.

It would be uncommon to find people arguing so, about say the pros and cons of template programming in the C++ language, or if Grutter v. Bollinger was correctly decided, or the determination of the solvability of a diophantine equation ;)

All of which are less complicated than markets and governments. But that doesnt seem to stop anyone from having opinions! There is something deceptively simple about economics and its discussion in the popular press that gets people thinking – hey this is easy!

Public ownership of industry is undesirable for the following reasons:

1. It reduces the overall standard of living of the nation: Government enterprises will consume economic resource (land, labor and capital) that could have been used more efficiently and productively by the private sector leading to greater (and better quality) employment and production.

2. It is inherently inflationary: Government consumption of resources reduces productivity. Consequently you have the stock of circulating money chasing fewer goods then would be otherwise, leading to inflation.

The aversion for private jobs in India in my view traditionally has been due to following reasons:

1. private owners would traditionally exploit the laborers and the profits accrued to them would not by exploiting the economic advantage in the market.
2. Years of such exploitation by inefficient industry has created a mindset that private sector exploits the labor class while the public sector having been run by the government though being inefficient would provided the much needed job security without exploitation.

Over the years after the reform with greater transparency and professionalism injected into the private sector, now we are seeing fruits of entrepreneurship sprouting and a liking for private sector is slowly craving in the minds of middle class.

Amit, if companies are really putting short term profits over long term survival, by definition they wouldn’t have survived. None of what you are saying refutes my point, which is that however bad some private companies are, public companies are much worse – and the reason they are worse is systemic.

ik, I’m okay with copying and pasting your economics textbook here, but please read what you write. The model free market you’ve described makes sense only if government firms are treated exactly the same as private firms – and that will mean that they will close down or get bought out when they do not perform. If that can’t be done, then public firms will certainly act as a drag on the economy.

And you write “Its an important strategy decision for survival of the firm, but for the whole economy, it should not matter.”. Does it occur to you that if the firm in question is a public firm, how the firm is doing matters to us because we are the owners of the firm?

Some of the private companies who follow this path (of focussing on short term) are on their way to extinction. Sometimes it is too late to back off.

Ummm…you cannot generalise that public companies are much worse than private. Let me illustrate a point with gold.

To mine infinitesimally small amount of gold, companies use open pit mining which requires lots of water, and also usage of sodium cyanide. A bit of carelessness and the whole aquifer (underground reservoir of water from which we draw well water aka ‘the water table’) is polluted with toxic substances. Now to get the gold, it will usually be a private company who want to dig it out, and leave the consequences to the government to handle. In the US, that has happened in other industries resulting in the creation of Superfunds.

ravikiran,
i am not disputing your conclusion, but the basis. i.e. ownersip inherently is bad for the taxpayers.

“The model free market you’ve described makes sense only if government firms are treated exactly the same as private firms – and that will mean that they will close down or get bought out when they do not perform. If that can’t be done, then public firms will certainly act as a drag on the economy.”
Do you agree this isn’t to do with ownership but catering to special interest group and redistributing wealth. This can very well occur with private enterprise as well.
Government in India has the power to legalise the regulatory behavior and create barriers to entry or redistribute wealth and in turn produce a lot of social waste.
But it still beats me how its related to ownership.

I am not saying I am right, but I somehow can’t build a model and convince myself about the owenership issue.

e.g. Consider Singapore Airlines. Its operating in a reasonably competitive market. (i.e. it has to compete with most of the other international airlines.) Do you see an ownership problem?

“Does it occur to you that if the firm in question is a public firm, how the firm is doing matters to us because we are the owners of the firm?”
Hold on a sec. Government owning the venture doesn’t necessarily mean that its financed by the tax payers money. GOvernment can issue binds, equity etc. and finance the venture. If its financed through taxpayers money and the good in question is not a public good, then yes a case can be made to invest taxpayers money for financing.

Singapore Airlines is an interesting example. It is owned not by the Singapore Government by itself, but by the Government’s investment arm, Temasek Holdings- at least the majority stake is. That means that the board of directors, who represent the ownership are much more independent than they would be in the Indian context.

And Temasek Holdings is run by Lee Kuan Yew’s daughter-in-law and there are allegations of mismanagement and nepotism, which are being suppressed by Singapore’s strict libel laws – already. Blood is always thicker than water. I am not very sure about Singapore’s reputation of being a well-governed state continuing for long after Lee’s death.

Ravi, I agree. But, my point really was about priorities. If you were to rank privatisation and competition, which one would be on the top?

Ownership matters, but competition matters more.

And, dont you see too many people talk as if reforms are all about privatisation. I am sure you would have seen these rankings here:
Ease of… Economy rank
Doing Business 116
Starting a Business 90
Dealing with Licenses 124
Hiring and Firing 116
Registering Property 101
Getting Credit 84
Protecting Investors 29
Paying Taxes 103
Trading Across Borders 130
Enforcing Contracts 138
Closing a Business 118

Not all of these are priorities for the Left. And, I would like to know what Manmohan Singh and P Chidambaram have to say about these (the other issues)? But most of the time, most of us talk only about privatisation.

And yes, it’s only my hope that Left would join in efforts to make things easier for people at large. I didnt know about Mr Sharad Rao earlier. Are you sure he is not an exception?

so you see,
the problem is not ownership, but inability of the government to delink the operations of one partifular firm from the rest of the governance.

this can happen with conglomarates as well. GE does lot of accounting management. HP’s printer division feeds off other divisions in loss.

I am not questioning the wisdom of government getting into all these other businesses. Its definitely wrong. May be its the same with GE and HP. the profitable divisions shouldnt feed other loss-making units. May be we will get better ROI on those investments. But there might be a different company who manages these things well.
The conclusion we can draw is, its difficult to to do a good job because of several reasons which the blogger has mentioned (misaligned incentives, corrput bodies etc.) but blaming ownership would be treating the symptom not the cause.

If you deregulate the market and have a good infrastructure (finance and law and order) then the owenrship issue wont be a problem. Either government would get out of these businesses or would do a great job competing.
Instead if you privatise, and dont have the surrounding infrastructure you can end up with monopolies based on some other shady criteria. The way logistics work in India a private enterprise monopoly might be a abtter idea than government running the show, but it still isnt the best solution absent of competitive markets and infrastructure.

We can debate on whats the best way to get there. May be privatisation is. I don’t know. But blaming that as the cause is something I can’t convince myself of. But then i am no expert.

ik, do you have a sensible point or are you simply saying “The government is not the problem . It is the way the government behaves that is the problem”?

Ramnath, I was talking of the specific question of PSU performance. There I say that it is ownership that matters, more than competition. I can go through all those points you’ve listed and I am sure I will find that any policy measure that will need to be taken to achieve it will be on the left’s oppose list. Hiring and Firing and Closing a business are easy ones, but the other ones like doing a business, starting business, etc. will have something to do with removal of FDI restrictions which the left opposes. I kind of agree that privatisation is not the most important reform measure. Product market liberalisation (i.e. SSI dereservation) is. Do you think the left will support that?

Sharad Rao does not belong to a left party, by the way, though he is a union leader. But why does that surprise you? What are the Kerala and WB communist parties on the ground? From what I know, they are just a bunch of middlemen. The Kerala CPM runs large industries itself.

Ramnath, Economist paid LHL 227,700. It also paid LKY separately – that’s around $400,000. In addition, Economist also paid for the legal charges …
the total payout works out to around $800,000 … now don’t ask me how I know … just be rest assured that I am saying this because i know :-)

Interesting debate in the Indian blogs about what matters more for economic performance: private ownership, or competition? Ravikiran Rao thinks that ownership is key. Ramnath thinks competition is more important. I think it’s a false dilemma. A priva…

Ravi: I was talking of the specific question of PSU performance. There I say that it is ownership that matters, more than competition. I agree.

And you are right: The Left will oppose product market liberalisation as well. But that certainly deserves more attention than privatisation. According to a McKinsey study, removing product market barriers would add 2.3% to our GDP growth (that is, with product market liberalisation GDP growth rate would be, say 9.3% against 7% without). But privatisation would add only 0.7%. (The report is downloadable from McKinsey site – MGI section)

Arvind Panagariya writes, for the Cato institute:The response of the economy to the reforms has been an order of magnitude weaker in India than in China… despite considerable growth, the share of industry did not rise in India.So?The necessary steps …